Why I'd steer clear of this heavily shorted FTSE 250 stock

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Ocado grocery delivery vans

Today, I'm looking at two of the most shorted stocks on the London Stock Exchange, Ocado Group(LSE: OCDO) and WM Morrison Supermarkets(LSE: MRW). With such heavy short interest in both, I'll be steering well clear of both.

A quick recap on shorting

For those unfamiliar with the concept of 'shorting', here's how it works. 

When an investor shorts a stock, it means that they are betting on the company's share price falling. Why would they want to do that? Well, they clearly think something is very wrong with firm, and they are expecting the share price to fall. The more the share price falls, the larger the profits for the short investor.

Shorters are usually sophisticated investors, such as hedge funds and institutions, so when a significant number of these guys are betting against a company, it's worth taking note... and proceeding with caution. And that brings me to Ocado and WM Morrison Supermarkets, which are both on the list below of the most shorted stocks at present. (If you need a reminder of what happened to Carillion shares recently, see my article here).

The 10 Most Shorted Stocks Right Now 

CARILLION PLC

23.1%

OCADO GROUP PLC

17.0%

WM MORRISON SUPERMARKETS

15.5%

WOOD GROUP (JOHN) PLC

14.8%

TELIT COMMUNICATIONS PLC

13.3%

DEBENHAMS PLC

12.4%

MARKS & SPENCER GROUP PLC

10.3%

SAINSBURY (J) PLC

10.1%

TULLOW OIL PLC

9.6%

AGGREKO PLC

9.3%


Source: shorttracker.co.uk

Ocado Group 

Online grocery retailer Ocado released a trading statement this morning for the 13 weeks to 27 August.

The company enjoyed group revenue growth of 14.3% to £344.5m, while average orders per week increased 16% to 254,000. The statement advised that at the end of the period, Ocado had cash and cash equivalents of £148.9m and external borrowings of £284.1m. Chief executive Tim Steiner commented: "We are pleased to report another strong quarter of growth. Our industry-leading technology has continued to set the bar for customer service and satisfaction and we continue to grow sales at a rate significantly in excess of the average for our industry."

While the trading statement sounds positive, there are two main reasons I won't be investing in Ocado. The first is the company's sky-high valuation. With the retailer expected to generate earnings per share of just £1.19 this year, the forward looking P/E ratio is an eye-watering 245. Furthermore, the company's debt levels look high relative to the profits that are forecast for the year. As a result, I won't be investing in Ocado shares for now. 

WM Morrison Supermarkets

Another stock high up on the most shorted list is WM Morrison Supermarkets. There's several reasons I won't be buying shares in this company either. 

The first is the competition that exists within the supermarket industry at present. While Morrisons enjoyed sales growth of 3.7% for the 12 weeks to the 18 June, ahead of peers Tesco (3.5%) and Sainsbury's (3.1%), its growth was nowhere near that of the German discounters. Indeed, during that period Aldi and Lidl recorded growth of 18.7% and 18.8%, respectively. This suggests to me that the discounters are still growing at a fast rate and looking to capture market share.

Furthermore, with analysts forecasting Morrisons to generate earnings per share of 12.3p for FY2018, the stock trades on a forward looking P/E ratio of a 19.1, higher than Tesco (18.8) and considerably higher than J Sainsbury (12.7). That valuation doesn't look appealing to me. 

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Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.